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Credit control is the system used by businesses and central banks to make sure that credit is given only to borrowers who are likely to be able to repay it. As such matters are rarely certain, credit controllers control lending by calculating and managing risk.
Credit control is part of the financial controls that are employed by businesses particularly in manufacturing to ensure that once sales are made they are realised as cash or liquid resources.
Credit control is a critical system of control that prevents the business from becoming illiquid due to improper and un-coordinated issuance of credit to customers. Credit control has a number of sections that include - credit approval, credit limit approval, dispatch approvals as well as collection process.
In a large business a credit process will be run by a senior manager and will include processes as such as Know Your Customer (KYC), account opening, approval of credit and credit limits (both in terms of the amounts and the terms e.g. 30 Days, 30 Days net), extension of credit and effecting collection action.
Credit control will normally report to the Finance Director or Risk Management Committee.
During the selling process a potential customer or even a current customer who pays cash may request for credit lines to be extended. At this point the following process may be followed:-
1. Formal letter of application for credit to be extended to a customer entity
2. Head of Finance evaluates the credit requested
3. Risk managers evaluate if the credit fits in with the current risk portfolio
4. Credit Collection period (usually in Days) is considered both as a stand-alone and as a component of the working capital cycle in particular ensuring that it does not exceed the Payables Period (usually in Days too).
5. External rating agencies may be invoked to assess the risk attached to extending credit to the customer. Usually credit worthiness of a firm may be assessed independently by firms such as Dun & Bradstreet, Bloomberg, AC Nielsen or other reputable firms.
6. Fillers are also made into the market to assess the credit worthiness of a firm
7. An internal evaluation is made considering the risk of Bad or Doubtful Debts against the profit or returns.
8. After Risk Manager and Finance Director is satisfied that the extension of credit will not result in loss of principal. Credit is extended.
9. An account is opened with the credit setting set for the agreed terms: Cap of credit the customer will enjoy and the terms or duration which they will enjoy that credit. In other words, the time-limit as well as the value of the credit are sides of the same coin.
Extended credit could, despite all efforts made, become noncollectable. In this case a professional Debt collection agency may be hired along with attendant legal, court and other fees. This event is normally dreaded and most Chartered Accountants are reluctant to consider that credit extended has now become noncollectable necessitating a debt write off if the receivable has gone bust or a provision if only a lower amount can ultimately be collected.
Unwarranted debt may be a serious strain on the company and could lead to company failure. Many SMEs have failed due to unsatisfactory Debt Collection processes or procedures. During the credit crunch many businesses experienced a serious credit risk and severely curtailed extension of credit to partner firms and businesses. Even though the current situation is much less severe credit extension remains a key, pivotal role in business management.
Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable to a third party at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs. Forfaiting is a factoring arrangement used in international trade finance by exporters who wish to sell their receivables to a forfaiter. Factoring is commonly referred to as accounts receivable factoring, invoice factoring, and sometimes accounts receivable financing. Accounts receivable financing is a term more accurately used to describe a form of asset based lending against accounts receivable. The Commercial Finance Association is the leading trade association of the asset-based lending and factoring industries.
In finance, valuation is the process of determining the present value (PV) of an asset. In a business context, it is often the hypothetical price that a third party would pay for a given asset. Valuations can be done on assets or on liabilities. Valuations are needed for many reasons such as investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability.
A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. The loss may be complete or partial. In an efficient market, higher levels of credit risk will be associated with higher borrowing costs. Because of this, measures of borrowing costs such as yield spreads can be used to infer credit risk levels based on assessments by market participants.
Accounts receivable, abbreviated as AR or A/R, are legally enforceable claims for payment held by a business for goods supplied or services rendered that customers have ordered but not paid for. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame. Accounts receivable is shown in a balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. These may be distinguished from notes receivable, which are debts created through formal legal instruments called promissory notes.
Underwriting (UW) services are provided by some large financial institutions, such as banks, insurance companies and investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liability arising from such guarantee. An underwriting arrangement may be created in a number of situations including insurance, issues of security in a public offering, and bank lending, among others. The person or institution that agrees to sell a minimum number of securities of the company for commission is called the underwriter.
Asset-based lending is any kind of lending secured by an asset. This means, if the loan is not repaid, the asset is taken. In this sense, a mortgage is an example of an asset-based loan. More commonly however, the phrase is used to describe lending to business and large corporations using assets not normally used in other loans. Typically, the different types of asset-based loans include accounts receivable financing, inventory financing, equipment financing, or real estate financing Asset-based lending in this more specific sense is possible only in certain countries whose legal systems allow borrowers to pledge such assets to lenders as collateral for loans.
Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Gross working capital is equal to current assets. Working capital is calculated as current assets minus current liabilities. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit and negative working capital.
Credit is the trust which allows one party to provide money or resources to another party wherein the second party does not reimburse the first party immediately, but promises either to repay or return those resources at a later date. In other words, credit is a method of making reciprocity formal, legally enforceable, and extensible to a large group of unrelated people.
Debtor finance is a process to fund a business using its accounts receivable ledger as collateral. Generally, companies that have low working capital reserves can get into cash flow problems because invoices are paid on net 30 terms. Debtor finance solutions fund slow-paying invoices, which improves the cash flow of the company and puts it in a better position to pay operating expenses.
Credit management is the process of granting credit, setting the terms on which it is granted, recovering this credit when it is due, and ensuring compliance with company credit policy, among other credit related functions. The goal within a bank or company, in controlling credit, is to improve revenues and profit by facilitating sales and reducing financial risks.
Loan origination is the process by which a borrower applies for a new loan, and a lender processes that application. Origination generally includes all the steps from taking a loan application up to disbursal of funds. For mortgages, there is a specific mortgage origination process. Loan servicing covers everything after disbursing the funds until the loan is fully paid off. Loan origination is a specialized version of new account opening for financial services organizations. Certain people and organizations specialize in loan origination. Mortgage brokers and other mortgage originator companies serve as a prominent example.
Trade credit insurance, business credit insurance, export credit insurance, or credit insurance is an insurance policy and a risk management product offered by private insurance companies and governmental export credit agencies to business entities wishing to protect their accounts receivable from loss due to credit risks such as protracted default, insolvency or bankruptcy. This insurance product is a type of property and casualty insurance, and should not be confused with such products as credit life or credit disability insurance, which individuals obtain to protect against the risk of loss of income needed to pay debts. Trade credit insurance can include a component of political risk insurance which is offered by the same insurers to insure the risk of non-payment by foreign buyers due to currency issues, political unrest, expropriation etc.
Asset and liability management is the practice of managing financial risks that arise due to mismatches between the assets and liabilities as part of an investment strategy in financial accounting.
Credit analysis is the method by which one calculates the creditworthiness of a business or organization. In other words, It is the evaluation of the ability of a company to honor its financial obligations. The audited financial statements of a large company might be analyzed when it issues or has issued bonds. Or, a bank may analyze the financial statements of a small business before making or renewing a commercial loan. The term refers to either case, whether the business is large or small. A credit analyst is the finance professional undertaking this role.
A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay a merchant for goods and services based on the cardholder's accrued debt. The card issuer creates a revolving account and grants a line of credit to the cardholder, from which the cardholder can borrow money for payment to a merchant or as a cash advance. There are two credit card groups: consumer credit cards and business credit cards. Most cards are plastic, but some are metal cards, and a few gemstone-encrusted metal cards.
A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets.
Under UK insolvency law an insolvent company can enter into a company voluntary arrangement (CVA). The CVA is a form of composition, similar to the personal IVA, where an insolvency procedure allows a company with debt problems or that is insolvent to reach a voluntary agreement with its business creditors regarding repayment of all, or part of its corporate debts over an agreed period of time. The application for a CVA can be made by the agreement of all directors of the company, the legal administrators of the company, or the appointed company liquidator.
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS).
Corporate finance is the area of finance that deals with the sources of funding, the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources. The primary goal of corporate finance is to maximize or increase shareholder value.
Supply chain financing is a form of financial transaction wherein a third party facilitates an exchange by financing the supplier on the customer's behalf. Also it refers to the techniques and practices used by banks and other financial institutions to manage the capital invested into the supply chain and reduce risk for the parties involved.
